Well-known private equity firms such as Blackstone, Carlyle, and Kohlberg Kravis and Roberts (more commonly referred to as KKR) also frequently acquire ownership and control of companies listed on public exchanges and take them private.
Other nonconventional forms of private equity include investment in collateralized debt obligations, structured transactions in listed companies (and delisting them from the exchanges), purchase of distressed debts through a special investment vehicle, as well as convertible debt (with option to convert into equity stakes at pre-negotiated valuations), and share swaps between unlisted companies to bring about a merger of two companies.
There are generally three reasons for investing in private equity; they are diversification, control, and return enhancement. While the performance of private equity is correlated with that of public equity markets, the imperfect correlation offers scope for investment diversification.
In both venture capital and buyouts, private equity firms typically control management, and in some cases they bring in new management to chart and implement new strategies for the companies.
The restructuring may involve divestments of certain business divisions, new acquisitions, or mergers with other companies. Since private equity can generate substantial returns, a small investment allocation to private equity in the institutional investment portfolio can enhance the overall performance of a portfolio.
The investment in private equity funds is usually opportunity-driven, due to the limited opportunities in investing in top funds. As such, the annual asset allocation for a fund manager in the private equity asset class may be dependent on the opportunities then available, which are dependent on the fund raising cycle of the private equity firms.
Private equity investing has grown explosively, with 75% of the growth of the last 20 years, that is from 1985 to 2005, connected in the last 5 years. However, private equity is still small in comparison with the public equity and fixed income asset classes. Globally, private equity average pooled net internal rate of return has outperformed public equity net returns over the past 20 years, in line with the higher risk of private equity investing.
A small number of the top private equity firms consistently achieved superior returns. There is no general agreement if superior performance is due to a particular investing style, or the size of the private equity fund and/or the size of the private equity deal.
The global private equity market has grown tremendously since 1990. At least U.S. $155 billion of private equity and venture capital was invested globally in 2003.
This is an increase of 43% on the 2002 level of U.S. $109 billion, equivalent to 0.48% of the world GDP. In 2004, $110 billion of private equity and venture capital was invested, down 5% from 2003 levels which is equivalent to 0.30% of the world’s GDP.